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Are you in need of money and considering a loan? Are you a homeowner? Then you may want to consider a home equity loan. In this article, we’re sharing everything you need to know about home equity loans, including how to get one and the best ways to use it.
What is a Home Equity Loan?
“Home equity” is your interest in your home, which will increase both as the value of the property increases and also as you pay off your mortgage loan. The more of the house you own, the greater your equity in it, which you can calculate with a Home Equity calculator.
As you pay down your mortgage and your home appreciates in value over time, your home equity will increase and become one of your most valuable assets. If needed, you can use this asset to take out what’s called a “home equity loan.” Your home will then be used as collateral against the loan, but you are still the homeowner.
A home equity loan usually offers a larger sum of money than a typical loan at lower interest rates. It can be a huge benefit to have in many circumstances, but home equity loans do come with some risk.
How Does a Home Equity Loan Work?
With a home equity loan, you have two options for borrowing money: a lump sum or a home equity line of credit (HELOC).
- With a lump sum: You receive a sum of money all at once, then pay it back over a period of time with fixed monthly payments at a fixed income rate. It’s amortized.
- With a HELOC: You will be approved for a certain amount, but only borrow what you need, as you need it. However, interest rates for HELOCs are variable and therefore can change (for better or worse) over your draw period.
HELOCs are considered to be the most flexible option for a home equity loan, as you have control over the loan balance and can withdraw multiple times once you have been approved. You will only pay interest on what you have actually borrowed from the available sum of money.
One of the benefits of choosing a HELOC is that you can make smaller payments at the start. However, be cautious with this: it means you will have larger payments due in the final years of your draw period. While draw periods are normally about ten years, it is important to note that HELOCs can be frozen unexpectedly at any time, so while this may be the more flexible choice, it tends to be riskier.
Borrowers should also know that the Canadian government has recently dropped the maximum loan value from 80% of the value of the home to 65% of the value of the home for HELOCs. It is possible to get a higher loan, but the difference will have to be amortized.
How to Get a Home Equity Loan?
There are several lenders in Canada who will offer you a home equity loan. Lenders will base their approval of your home equity loan on several factors including the equity of your property, your employment, your debt-to-income ratio, and your credit score.
While terms for each lender will differ, those who apply for a loan should have the following:
- Minimum 15-20 percent equity in the property
- Secure employment with a solid and regular income record
- A debt-to-income ratio of less than 43 percent
- A credit score of a minimum 620 (learn more about getting your free credit score check with Borrowell)
To get the best home equity loan, apply to several lenders so that you can compare costs and interest rates. Look to both the big name banks as well as digital lenders.
Can You Use a Home Equity Loan for Anything?
Once you have been approved for a home equity loan you can technically use the money for anything you wish. However, you need to remember that at the end of the day, this is your home on the line – so make sure to use the loan accordingly.
The best way to use your home equity loan is for long term goals that will lead to a higher income for your family or add significant value to your assets or life. Common examples include paying for a child’s education, starting a business, or even home improvements that will boost the overall value of your house. Luxury spending on things such as a vacation or a new car is not the best way to use your home equity loan.
Home Equity Loan Process Time
Once you have applied for a home equity loan, it will likely take several weeks before you can access your loan. The lenders will do a detailed check into your credit history and may also require a home appraisal before approving your home equity loan.
Pros and Cons
In many situations, a home equity loan can be a great option with plenty of benefits. However, it’s important to be mindful of the drawback as well.
In terms of benefits, home equity loans are especially attractive to borrowers because the loans can be quite significant. In many cases, a home equity loan is the only way a borrower can have access to this type of funding. Another huge benefit of a home equity loan is that the interest rate is often significantly smaller than that of a credit card.
As for the drawbacks, the biggest thing you need to remember is that your home is at stake. If you don’t make payments, it can literally be sold from under you. Always keep that in the back of your mind when using your home equity loan and prioritize these payments above others.
A home equity loan can be an ideal way to help you reach your goals. Not just in terms of the amount of money you can get, but also because a home equity loan can be a better choice, financially, than another type of loan or even a credit card. Just remember to be smart and cautious using it because, at the end of the day, it’s your home that’s on the line.